Why businesses fail

Another article, among many that I wrote during my previous job. This one, however, is an inspired article, from something I read on one of the very popular websites for business advisory in the UK.

Nearly half of the newly established businesses lose out in the first 3 years of their lives. For each kind of business, there may be several factors leading to this eventual climax, and each reason leads to the final conclusion of a business failure.

One of the major and very recognisable factors that heavily threaten a business, especially the small and/or medium enterprise, is the lack of strong financial backing, and that is usually coupled by the inability of appropriately managing the available resources. However, failures or losses are not always the result of the incapability of the business itself; rather, they respond to events occurring in the environment, including customers and suppliers. It is therefore imperative that any symptoms arising should be recognised before they really create an irreversible situation.

A business failure is commonly believed to result in the insolvency of the business, where it does not remain in the capacity or ability to continue its trading activities, and thus even come close to cover its operating costs. According to accountants, this would mean a situation where the business is not in the position to even settle its variable costs.

There are several reasons associated with the eventual collapse of the business,
• Management Incompetence
• Lack of financial control
• Financing difficulties
• Overtrading
• Bad debt
• Mismanaged priorities

Management Incompetence

To start off successfully, managers are expected to be skilled and competent in the field they have ventured. They may not necessarily be specialists or experts in it, but need to have the basic skills that will not only allow them to handle the business and its entire workforce, but must be able to train employees if required.

If you do not have the required skill to completely manage the affairs, then you should make sure that your staff can efficiently cover up what you have missed; in addition, they should also remain loyal to the future of the business.

Before starting off, you should ensure that you are prepared, mentally and physically, to venture on the task ahead, knowing that whatever you can do, or have the ability to do right now is surely going to have an impact on the success of the business. This means that if you have time to prepare well before initiation, or while running the business, you should take up the opportunity to arm yourself with the most updated information and skills available, ensuring a better standing when you urgently need it.

Lack of financial control

Many businesses fail primarily due to the mismanagement of cash flow in the organisation. Usually, this is the result of poor accounting techniques and practices, which consequently result in failure.

You should hire a skilled accountant, who may not be qualified but should be able to produce accounts, and manage the company’s cash flows and assign appropriate budgeting techniques to gauge performance and possibly help in identifying and eliminating shortfalls. The properly formatted financial statements can be useful internally and externally – banks and other financial institutions, potential and existing shareholders/investors, creditors etc. Budgets and cash flow statements are generally produced for internal use, and assessed to formulate a strategy for the proceeding period.

If you do not wish to employ a specialist, you should consider training members of your current staff to perform the task or get some training and/or assistance yourself by enrolling in evening or weekend classes. Occasionally, however, you should consider calling in an independent practitioner or bookkeeper to assist in preparing your accounts and records for compliance purposes and advisory.

Financing difficulties

Small and medium sized businesses generally undergo the phase of marketing their idea and generate initial capital. This usually is the primary reason for failures in the initial period, when the businesses don’t even have a thorough footing or sometimes even don’t have any sense of direction either.

Small companies are normally facilitated by close friends and members of the family. The other most prominent source of finance available to them is from banking institutions and other lenders, usually on collateral basis. This often leads to excessive borrowing, with a liability to pay back according to the contracted period. In addition, they stress the company’s cash reserves as these are interest bearing financing options, and therefore must be expended regardless of a profit or loss.

Shortage of funds can also arise as a measure to launch in an already competitive market. Companies normally have to launch their products at extremely competitive prices to secure even a small percentage of the market share, which may already be clogged up by competitors. To avoid this finance draining activity, make sure that you venture into a market which has little or no competition, especially not when you are starting up.


Most companies are taken aback by the enormous potential of the market and consciously or unconsciously start overtrading. This involves selling more than the company is able to deal with at a particular time. Overtrading is considered to be a natural act by sales managers, but has its downfalls, including the inability of customers to pay up their liability.

Some managers prefer short-term profit taking and growth, whereas most managers and shareholders as well consider long-term goals to be of prime importance. And quite frankly, companies who want to make it big in the foreseeable future, have to rely on steady growths and avoid hasty decision making, which does nothing but plunge the business into darkness. Managers should make sure that no such contracts or agreements are engaged which may create a problem for the company in the long-term.

Overtrading also involves heavy borrowings as variable and fixed costs increased significantly and is a drain on the capital. But if customers are dealing in cash, then there are no problems, because the major crunch is in credit sales, and this always leads to short-term insolvency, which obviously translates into business failure. Such an event can be prevented by appropriate planning and budgeting for receipt of orders and receipt of cash against invoices. Furthermore, companies should take up the overdraft facility available from banks, which help in avoiding a critical situation where no cash is available.

Bad debt

Overtrading often leads to situations when customers are not investigated, which means that s/he may or may not have a respectable status and/or credit reputation. Some customers are reputed slow payers, but do eventually pay up, whereas a few just cannot make good at all. In either case, the business is bound to face cash flow problems in this respect. Imagine a major customer going insolvent, who happens to have a significant amount owing to the business. To add to the agony, any amounts you receive from the insolvency will be based on the customer’s priority list.

The best way to scan a customer is by obtaining a credit report or a bank reference. And most important of all, be aware of any small hints from the customer, such as delays in payment, or payment in instalments etc. in such an event, try to persuade the customer to pay cash upfront, or avoid making any valuable sale to them.

Mismanaged priorities

Many companies have problems in sorting out their priorities correctly. Although this should have been pre-planned, i.e. decided on before the business started, they keep tossing them about and setting them in order on a trial and error basis. Nevertheless, at each stage of the business run, priorities do change, and it is quite a healthy practice to do so. But at the initial stage it is imperative that schedule is progressive and not haywire.

The basic framework should be (a) starting up; (b) establishing a proper stature; and (c) competing. At each stage, the business should review its current status and prepare a plan for the next step. This includes monitoring of any events that lead to a quick initiation of a second phase of the plan, without a proper ramp to project it.

While developing your business plans and progression strategy, make sure that you have you have properly studied the likelihood and the impact of the proposed plans and development stages before you churn them up.

Preventing a failure

It all comes down to a good management strategy and planning. If you wish to completely avoid the risk of failure, then you can forget about running a business altogether. The best way to start up successfully is with a sufficient back up of finances and a proper resource management programme, and a practical business plan that can be implemented. You may face hardships in the first couple of years, but that is all part and parcel of the business package, which must be accepted. In addition, you may need a bit of your own PR to get you on the right foot at a faster rate.

An important question that you should ask yourself before you construct a business plan is: are you the right man for the job? Just because you THINK you can do something is not the solution for success. What you really need is the confidence, the temperament, and the ability and skill to make your move worthwhile.

Any weakness in any of the plans can push your business into a strain resulting in failure. Since there are several reasons for a falling business concept, it is ever so important to realise the point which changed the direction of your prospects from upward to a gradually slowing and a sudden shift downward. Once things are going down, it is very difficult to reverse the trend, and it is up to you to note the signals and make an attempt and save your boat.


2 responses to “Why businesses fail

  1. ever thought of goin in2 the writing field?? hehehhhe.

    p.s. i didnt read this..looks brain confuzzling nd businessy! neither go well with me!!

  2. ever thought of goin in2 the writing field?? hehehhhe.

    p.s. i didnt read this..looks brain confuzzling nd businessy! neither go well with me!!

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